Most people are served by financial institutions in some way, as financial operations are a critical part of any economy, with individuals and businesses relying on financial institutions for transactions and investing. Because banks and financial institutions play such an important role in the economy, governments consider it essential to oversee and regulate them. Here, we’ll discuss the 7 functions of a financial institution and how the GLBA regulates them.
What Is A Financial Institution?
A financial institution is a business that deals with financial and monetary transactions like deposits, loans, investments, and currency exchange. Financial institutions include a wide range of financial services business operations such as banks, trust companies, insurance companies, brokerage firms, and investment dealers.
Almost everyone in a developed economy requires the services of financial institutions on a regular or at least periodic basis.
Financial institutions range in size from small community credit unions to large international investment banks.
What Are The 4 Types Of Financial Institutions?
Individual and commercial clients can benefit from a wide range of products and services provided by financial institutions. The specific services provided by different types of financial institutions vary greatly. The types of financial institutions available include:
#1. Commercial Banks
A commercial bank is a type of financial institution that accepts deposits, provides checking account services, makes business, personal, and mortgage loans, and provides basic financial products to individuals and small businesses such as certificates of deposit (CDs) and savings accounts. In contrast to an investment bank, most people do their banking at a commercial bank.
Banks and similar business entities, such as thrifts or credit unions, provide the most well-known and widely used financial services, such as checking and savings accounts, home mortgages, and other types of retail and commercial loans. Banks also serve as payment intermediaries for credit cards, wire transfers, and currency exchange.
#2. Investment Banks
Investment banks specialize in services that help businesses run more smoothly, such as capital expenditure financing and equity offerings, including initial public offerings (IPOs). In addition, they frequently provide brokerage services to investors, act as market makers for trading exchanges, and manage mergers, acquisitions, and other corporate restructurings.
#3. Insurance Companies
Insurance companies are among the most well-known non-bank financial institutions. Whether for individuals or businesses, insurance is one of the oldest financial services. Asset protection and financial risk protection, as provided by insurance products, is a critical service that facilitates individual and corporate investments that fuel economic growth.
#4. Brokerage Companies
Investment firms and brokerages, such as Fidelity Investments, which provides mutual funds and exchange-traded funds (ETFs), specialize in investment services such as wealth management and financial advisory services. They also provide access to a wide range of investment products. These products range from stocks and bonds to lesser-known alternative investments like hedge funds and private equity investments.
What Is the Importance of Financial Institutions?
Financial institutions are necessary because they provide a marketplace for money and assets, allowing capital to be allocated efficiently to where it is most useful. A bank, for example, accepts customer deposits and lends the funds to borrowers. Any individual is unlikely to find a qualified borrower or understand how to service the loan without the bank acting as an intermediary. As a result, the depositor can earn interest through the bank. Similarly, investment banks locate investors to whom a company’s shares or bonds can be sold.
What Are The 7 Functions of A Financial Institution?
#1. Price Calculation
The financial institution serves as a price discovery mechanism for the various financial instruments traded between buyers and sellers on the market. Market forces, such as demand and supply, determine the prices at which financial instruments trade in the financial market.
As a result, the financial market serves as a vehicle for pricing both newly issued financial assets and existing stock of financial assets.
#2. Mobilization of Funds
Participants in the financial market determine not only the prices at which financial instruments trade in the financial market but also the required return on the funds invested by the investor. The motivation for those seeking funds is determined by the required rate of return demanded by investors.
Because of this function of the financial market alone, it is signaled that funds available from lenders or investors of funds will be allocated among those in need of funds or raised through the financial market’s issuance of financial instruments. As a result, the financial market aids in the mobilization of investors’ savings.
#3. Availability of liquid assets
The liquidity function of the financial market allows investors to sell their financial instruments at the market’s current fair value at any time during the market’s working hours.
If the financial market lacks a liquidity function. The investor is compelled to hold the financial securities or financial instrument until conditions in the market arise to sell those assets or the issuer of the security is contractually obligated to pay for the same, i.e., at the time of maturity in the case of a debt instrument or at the time of the company’s liquidation in the case of an equity instrument is until the company is either voluntarily or involuntarily liquidated.
As a result, investors can easily sell their securities and convert them into cash in the financial market, providing liquidity.
#4. Risk allocation
The financial market serves as a risk-sharing mechanism because the person undertaking the investments is distinct from the person investing their funds in those investments.
The risk is transferred from the person who makes the investments to those who provide the funds for those investments through the financial market.
#5. Simple Access
Investors require industries to raise funds, and industries require investors to invest their money and earn returns on it. As a result, the financial market platform makes it easy for potential buyers and sellers to find each other, saving them time and money.
#6. Transaction Cost Reduction and Information Distribution
During the transaction of buying and selling securities, the trader requires various types of information. It takes time and money to obtain the same results.
However, the financial market assists in providing all types of information to traders without requiring them to spend any money. In this way, the financial market lowers transaction costs.
#7. Capital Formation
Financial markets serve as a conduit for new investors’ savings to flow into the country, assisting in capital formation.
What Is the Gramm-Leach-Bliley Act (GLBA)?
The GLBA, also known as the GLB Act or the Financial Modernization Act of 1999, was enacted on November 12, 1999, and requires financial institutions to “explain their information-sharing practices to their customers and to safeguard sensitive data.”
By ensuring the confidentiality of customers’ private and financial information, the law aimed to modernize the financial industry and strengthen consumer data privacy safeguards.
In general, the GLBA requires every financial institution to take steps to ensure the confidentiality and security of their customers’ “nonpublic personal information” (NPI). Furthermore, the regulation restricts the disclosure of NPI to unaffiliated third parties.
This means that financial institutions must inform customers about their information-sharing practices and give them the option to “opt-out” of having their data shared.
The Federal Trade Commission (FTC) is the primary agency in charge of enforcing the GLBA. State laws may require greater compliance, but not less than what the GLBA requires.
What Is a “Financial Institution” According to the GLBA?
The GLBA defines “financial institutions” as businesses that are “significantly engaged” in providing financial products or services to individual consumers or customers, such as loans, financial or investment advice, insurance, and so on.
The GLBA applies to these organizations as well as their “affiliates,” which are defined as any entity that receives consumer financial information from a financial institution.
This category includes a wide range of businesses of all shapes and sizes, including, but not limited to:
- Banks.
- Mortgage lenders who are not banks
- Brokers
- Some financial or investment consultants
- Debt collectors
- Preparers of tax returns
- Providers of real estate settlement services and appraisers
In addition to straightforward financial institutions and those that directly collect NPI from customers or consumers, entities that receive consumer financial information from a financial institution may be subject to restrictions under the Financial Privacy Rule — one of the three sections of the GLBA.
Maintaining Compliance with the GLBA: The GLBA’s Three Sections
The GLBA is divided into three sections, each of which establishes a different rule:
Financial Privacy Regulation
The Financial Privacy Rule (or simply the Privacy Rule) is primarily concerned with practice disclosure. It requires financial institutions to provide clear and conspicuous written notice to their customers (and sometimes consumers) describing their privacy practices and policies.
Organizations must provide each customer with a privacy notice when they first become a customer and every year thereafter.
The notice must include the information gathered about the customer, where it is shared, with whom it is shared, and how it is used and protected. It also specifies the customer’s right to refuse the sharing of their information with third parties.
The distinction between consumers and customers is important under GLBA because the law requires companies to provide these notices to all of their customers, but only to specific consumers.
The Safeguards Regulation
The Safeguards Rule is primarily concerned with information security. It requires financial institutions to safeguard the customer information they collect. Companies must develop a written information security plan that describes how they protect their data in order to comply with the rule.
Some of the safeguards they must provide include:
- Designating employees to coordinate an information security program
- Assessing risk in each area of the business
- Monitoring and testing safeguards.
- Keeping contractors who meet compliance standards
As business operations and risk assessments change, we must constantly evaluate and optimize.
Companies must also protect sensitive information from unauthorized access and monitor user activity, including attempts to access protected records.
The specific requirements vary depending on the size, complexity, and circumstances of the company, but they are all designed to ensure that financial institutions address risks to customer information across all areas of their operations, particularly employee management and training information systems.
The Pretexting Prohibition
The Pretexting Prohibition basically states that you must not lie to institutions or customers in order to obtain information.
Pretexting is the practice of gathering information under false pretenses or knowingly convincing customers to reveal information in the context of a fabricated story. The prohibition prohibits using false, fictitious, or fraudulent statements to obtain customer information, whether obtained from a financial institution or directly from a customer.
Fines, Violation Penalties, and Compliance Benefits Under the GLBA
Financial institutions that violate the GLBA face civil penalties of up to $100,000 per violation.
Officers, directors, and other individuals in charge of the organization may also face personal fines of $100,000 for each violation, as well as up to five years in prison. In other words, non-compliance can be harmful to both businesses and individuals, as well as life-changing.
Organizations that comply with GLBA, on the other hand, not only avoid financial penalties but also increase customer trust and loyalty. When customers feel secure in the way their financial institution handles their information, it can boost reputation and repeat business.
Exemptions from the CCPA for Financial Institutions: Data Protected by the GLBA
Financial institutions are subject to new regulations as a result of the CCPA’s passage.
While the CCPA allows for exemptions on specific data covered by the GLBA, it does not exempt financial institutions themselves. The exemption applies to data that has already been “collected, processed, sold, or disclosed in accordance with the federal Gramm-Leach-Bliley Act.”
However, the CCPA defines “personal information (PI)” as “information that identifies, relates to, describes, is capable of being associated with, or could reasonably be linked, directly or indirectly, with a specific consumer or household.”
So, while NPI is exempt from CCPA compliance and the California Attorney General’s Office’s scrutiny, PI is not. Simply put, whenever a financial institution collects information for non-financial purposes — or draws “inferences” from that data — it is subject to the same CCPA requirements as everyone else. Consider marketing data, website visitors, and geolocation data.
Financial institutions are also subject to the CCPA’s private action right, which allows consumers to seek statutory damages in the event of a breach.
Who Comes Under Financial Institutions?
Financial institutions majorly encompass central banks, retail and commercial banks, internet banks, credit unions, savings and loan (S&L) associations, investment banks and companies, brokerage firms, insurance companies, and mortgage companies.
What Is The Difference Between A Bank And A Financial Institution?
The difference between a bank and other nonbanking financial institutions is that banks can accept deposits into savings and demand deposit accounts, unlike other financial institutions.
In Conclusion
Banks, trust companies, insurance companies, brokerage firms, and investment dealers are examples of financial institutions that provide a wide range of business operations in the financial services sector. Financial institutions in the United States are regulated by agencies such as the OCC, the SEC, the FDIC, and the Federal Reserve.
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